It may be folly to follow funds of funds in their uphill struggle

Monday 11 February 2008 08:34 BST

Retail fund management is unique in being a professional service that is more expensive in real terms today than it was 20 years ago. Computers, technology, systems, outsourcing and other innovations have allowed other professions to cut costs and hold or reduce their prices to clients. Not so in fund management.

It is likely to get even more expensive. Recent quarterly figures from the Investment Management Association showed a marked increase in the popularity of funds of funds - so much so that the proportion of net retail sales being allocated to funds of funds increased from 14.2% in the first half of 2007 to 23.6% for the final six months.

I have never been convinced about funds of funds since, 40 years ago, legendary fund-management rogue Bernie Cornfeld of Investors Overseas Services succinctly summed up their attractions to him as a manager as "two sets of fees". The clients in effect pay to have their money managed twice.

It was subsequently discovered that Cornfeld could manipulate the performance of illiquid lower-tier funds - which he did to spectacular effect in one particular case - so he got two lots of performance fees as well, at the lower and at the fund of funds level.

If the retail public wants to go for a fund of funds, so be it. But the case is unconvincing. There is not enough profit in the markets, particularly the liquid competitive Western markets.

All the gain gets mopped up by fees, dealing costs and tax and, although they seem totally unwilling to admit it, most private investors would be far better off with a dirt cheap tracker fund as provided by Legal & General and Barclays Global Investors.

The bigger issue is that two layers of charges and two layers of management do not seem to equate to two layers of skill. As a class, funds of hedge funds do not seem to have done particularly well in the last six months, and have not delivered on their implied promise to see trouble coming and get clients out of the dangerous parts of the market in good time.

More generally, if a fund manager is incapable of picking the winning shares from the FTSE 100 - and statistically a majority of them fail this test after charges - why would another of his or her ilk be any better at picking the winning investment funds from a similar-sized universe?

Indeed, one would expect the fund of funds to do worse because finding a winning fund is statistically more difficult than finding a winning share, there being more investment funds in the UK than there are listed shares. Nonsense but true.

Not everyone agrees with, this of course. When New Star reported last month, it confessed to having a torrid time. But marketing director Richard Wilson said in a press release last week that in the current volatile markets "the flexibility of a global remit and the ability to change the blend of funds rapidly within our most popular funds of funds...has been a real advantage".

Well, we shall see. But meanwhile I suspect that avoiding the losers and finding the winners in these markets may prove to be harder than he thinks. CHARLES ALLEN'S time at ITV was so disappointing that its long-suffering shareholders forced him to retire even before they had found a successor, so keen were they for him to go.

Under his watch, programmes became dire and ratings plummeted. He was also locked into a complex arrangement with advertisers that meant ITV had to rebate money when audiences fell short - a deal Allen himself had promoted as a way to get official approval for the creation of ITV from Granada and Carlton.

His time before, when he ran Granada, was not that great either. Even the much-vaunted 1996 takeover and break-up of Trusthouse Forte is considered by most analysts to have destroyed, rather than created, value.

Yet he clearly has his supporters because, armed with private money, Allen has moved into the commercial radio business and is trying to buy GCap, the owner of Classic FM, Capital and a host of others.

In a sane world, people would be so helpless with laughter at the thought of selling to Allen that they would be unable to sign the acceptance forms. Unfortunately, he has to be taken seriously because CGap's shares are at rock bottom and boss Fru Hazlitt is today going to sell the future by ditching most of CGap's commitment to digital radio to keep him at bay.

Her predecessor, Ralph Bernard, had a hugely convincing vision for digital, which he said would in time transform the group because it would give it a string of national stations to run alongside Classic. All that money down the drain and now we will never know whether or not he was right. But with Allen breathing down her neck, perhaps Hazlitt had no choice.